Application of Marginal Costing

Make or buy Decision

Q.1 A manufacturing company finds that while the cost of making a

components part is Rs 10, the same is available in the market at Rs. 9 with an
assurance of continuous supply. Give your suggestion whether to make or buy
this part. Give also your views in case the supplier reduces the price from Rs. 9
to Rs. 8.

The cost information is as follows:

Materials 3.5
Direct Labour 4.00
Other Variable Expenses 1.00
Fixed Expenses 1.5

Solution:

To take a decision on whether to make or buy the component part, fixed

expenses being irrelevant cost should not be added to the cost because these
will be incurred even if the part is not produced.

Thus, additional cost of the part will be as follows:

The company should produce the part if the part is available in the market at
Rs. 9.00 because the production of every part will give to the company a
contribution of 50 paise (i.e., Rs. 9.00 – Rs. 8.50).

The company should not manufacture the part if it is available in the market at
Rs. 8 because additional cost of producing the part is 50 paise (i.e., Rs. 8.50 –
Rs. 8) more than the price at which it is available in the market.

By: Dr. Ankit Goel Page 1

Q.2Ride-well Cogcle Ltd. purchases 20,000 bells per annum from an outside
supplier at Rs. 5 each. The management feels that these be manufactured and
not purchased. A machine costing Rs. 50,000 will be required to manufacture
the item within the factory. The machine has an annual capacity of 30,000
units and life of 5 years.

The following additional information is available:

Material cost per bell will be Rs. 2.00
Labour cost per bell will be Re. 1.00
Variable overheads 100% of labour cost
You are required to advise whether:
(i) the company should continue to purchase the bells from the outside
supplier or should make them in the factory

(ii) the company should accept an order to supply 5,000 bells to the market at
a selling price of Rs. 4.50 per unit ?

Solution:

Therefore, the company should manufacture the bells resulting in a saving of

Rs. 10,000 annually for 20,000 bells.

(ii) Marginal cost per bell is Rs. 4.00 as shown above. As depreciation of the
machine is recovered on 20,000 bells, there will be no additional depreciation

By: Dr. Ankit Goel Page 2

on the extra 5,000 bells to be sold in the market. Further the machine has
additional capacity too. Therefore, the company is advised to supply 5,000
bells to the market at Rs. 4.50 per unit and make a profit of Re. 0.50 per unit
i.e., total profit Rs. 2,500.

Product Mix

Q.1

Present the following information to show to the management:

(i) The marginal product cost and the contribution per unit.

(ii) The total contribution and profits resulting from each of the following
sales mixtures.

Sales mixtures :
(a) 100 units of Product A and 200 of B
(b) 150 units of product A and 150 of B
(c) 200 units of product A and 100 of B
Recommend which of the sales mixtures should be adopted.

(iii) The proposed sales mixes to earn a profit of Rs. 250 and Rs. 300 with
total sales of A and B being 300 units.

By: Dr. Ankit Goel Page 3

Solution:

By: Dr. Ankit Goel Page 4

 Q.2

A multi product Company has the following costs and output

data for the last year.

By: Dr. Ankit Goel Page 5

 A comparison of the old situation and proposed change shows that if
product Z is replaced by product S it would increase the profit by Rs. 15,000
and break even point will reduce by Rs. 21,760. The change is beneficial and,
therefore, product Z may be dropped.

Changes in Selling Price

Question: 518 23.19

A company produces a single product which is sold by it presently in the

domestic market at Rs. 75 per unit. The present production and sales is
40,000 units per month representing 50% of the capacity available. The cost
data of the product are as under : Variable costs p.u. 50; Fixed costs per
month Rs. 10 lakh. To improve the profitability, the management has 3
proposals on hand as under:

(a) to accept an export supply order for 30,000 units per month at a
reduced price of 60 per unit, incurringadditional variable costs of Rs. 5 per
unit towards export packing, duties etc.;

(b) to increase the domestic market sales by selling to a domestic chain

stores 30,000 units at 55 per unit, retaining the existing sales at the existing
price;

(c) to reduce the selling price for the increased domestic sales as advised
by the sales department as under:

Reduce selling price Increase in sales

per unit by Rs. expected (units)

5 10000
8 30000
11 35000
Prepare a table to present the results of the above proposals and give
your comments and advice on the proposals.

By: Dr. Ankit Goel Page 6

Q

The following details have been extracted from the annual budget of Classic Manufacturing Co. Ltd. for
the year 2016-17:

Particulars Per Unit ( Rs.) Per Annum ( Rs.)

Selling Price 300
Direct Materials 64
Direct Labour 48
Production Overheads
Variable 32
Fixed 40,00,000
Administrative Overheads- Fixed 30,00,000
Selling & Distribution Overheads
Variable 36
Fixed 20,00,000

Currently the company is operating on a margin of safety of 25%. To improve its

profitability further, the company is considering the following options:
(i) Reduce selling price by 5%. Sales volume is expected to increase by 20%. Also
fixed production overheads will increase by Rs. 2 lakhs and fixed selling and
distribution overheads by 3 lakhs.
(ii) Increase selling price by 5%. This will cause a drop in sales volume by 10%.
To arrest further fall in sales, an increase of 2 lakhs will be required under fixed
selling and distribution overheads.
(iii) Production can be increased by 15% by introducing an incentive scheme for
labour. This will increase directlabour cost by 25%. An additional expenditure of
Rs. 3 lakhs would be required under fixed selling and distribution overhead to
market the increased production.

Required:
(a) Current level of production/sales and profit earned.
(b) Assuming that (i), (ii) and (iii) are mutually exclusive and other items remain
unaffected, evaluate each of these option:
(c) If the company is able to reduce raw material cost by 5 per unit by making bulk
purchases and reduce the fixed overhead costs by 2 lakhs by suitable economy
measures, at what selling price per unit should it sell its current production to earn
a 10% increase in current profit ?

By: Dr. Ankit Goel Page 7